Investment column: Sold on fear

Craig Bodenstab | December 1, 2014

Pandemic worries can mean opportunities for investors

At the end of September, the U.S. saw its first confirmed Ebola case. While the disease had been spreading through West Africa since March, the first known U.S. case made it no longer others’ problem. Fear of an outbreak led to quarantines in certain states, greater airport screenings—and widespread distortion of the facts.

An October poll showed about 40% of Americans felt they, or someone they knew, were personally at risk from the disease. In reality, dying from a lightning strike is more likely.

While disproportionate fear in the public can create risks, in stock markets, it can sometimes create opportunities.

Afraid to Fly
As Ebola fears spread to capital markets, investors became particularly wary of travel company stocks. Most major cruise companies and airlines sold off by 10% or more in the first two weeks of October, reducing the market value of these companies by $23 billion. To some degree, this wasn’t surprising, given that someone with suspected Ebola exposure was on a Carnival cruise. Though that was a false alarm, it’s easy to imagine the disease spreading on a plane or a ship.

For equity investors, the most important determinant of long-term returns is the relationship between a company’s share price and the value of the underlying business. When prices fall, investors must determine if the underlying business has lost value. If it hasn’t, a declining share price may represent a buying opportunity.

To put these events into perspective, consider SARS in 2003 and the H1N1 outbreak in 2009. There are differences: Ebola has a higher fatality rate, for instance, but it’s also harder to transmit. With both SARS and H1N1, the point of maximum news coverage signalled the beginning of the end of pandemic fears.

In the case of SARS, a March 2003 World Health Organization (WHO) travel alert caused a sell-off in the shares of Cathay Pacific airlines, Genting Hong Kong (operator of Star Cruises in Asia) and other companies exposed to Hong Kong tourism. When the WHO lifted travel warnings in late May, these shares had already rebounded in anticipation—in Genting’s case, by more than 20%.

With H1N1, the escalation of public interest took about six months, and the peak of news coverage and web searches lasted about three weeks in October 2009. During those weeks, the share prices of Carnival and Royal Caribbean cruise lines both fell by 10% to 15%. As H1N1 fears dissipated over the following three months, Carnival’s share price rose by 12%, and Royal Caribbean’s, by 25%.

It’s hard to know for sure, but we may well be past the point of peak fear for Ebola. In mid-October, Internet searches for Ebola surpassed the peak levels of H1N1, and the pandemic received more news coverage than the World Cup did in the week of the final match.

While this provides a rough gauge of sentiment, it doesn’t preclude a meaningful hit to companies’ underlying fundamentals. Should consumers become disproportionately risk-averse, they may avoid booking cruises or flights.

In fact, that’s what happened in 2009. Amid reports of H1N1 spreading on cruises and an outbreak in Mexico, bookings fell, and cruise lines had to change itineraries. But in the case of Carnival, for example, this reduced earnings per share by only about 4%. Today, however, major cruise lines have no stops in West Africa, and there haven’t been any reported cases of Ebola spreading on a ship.

Only time will tell if investors’ fears about Ebola were truly warranted. But by keeping a balanced view of risk and focusing on the relationship between price and fundamental value, long-term investors may find opportunities amid the fear.

Craig Bodenstab is head of investment counselling at Orbis Investments.